What is a Depository System?
Introduction of Depository system
gives way for dematerialization of shares. A Depository is an organization
which holds the securities of a shareholder in electronic form at the request
of the shareholder.
The development of Information
technology has paved the way for many innovative things in the stock exchange.
The stocks scam which shook the stock market during the 1990s also made the
government to take preventive measures to avoid the recurrence of such scams.
All these resulted in the introduction of a new type of stock trade
called dematerialization .
Advantages and disadvantages of the Depository System
Features of Depository System:
A depository system has the
following features:
(a) Day-to-day basis of reconciliation is made by
NSDL;
(b) Securities
are divisible and, as such, can be transacted by any quantity;
(c) Securities are allotted International Security
Identification Number (ISIN) by SEBI;
(d) The benefit of depository system is enjoyed by the
investor/owner of securities; and
(e) CDSL and NSDL are the Depository Participants to
act as agent.
Advantages
of Depository System:
Enjoyed by Investors:
i. It eliminates bad deliveries;
ii. It computes the settlement cycle very fast;
iii. It makes immediate transfer and registration of
securities;
iv. It eliminates all risks associated with physical
certificate;
v. It also provides nomination facility to the
investors;
vi. It reduces trading cost;
vii. Since it is paperless trading, no share
certificate and deed etc. are required.
Enjoyed by the Capital Market:
(i) Dues are
settled in a very short time;
(ii) It also eliminates bad delivering;
(iii) It also eliminates the problems arising from odd
lots of securities;
(iv) It eliminates the physical handling of
paperwork’s;
(v) It reduces errors;
(vi) Questions of loss, mutilation of securities does
not arise.
(vii) Huge number of transactions can be settled at a
very short time.
Enjoyed by the Company:
(a) It reduces the risk of loss of securities and, at
the same time, reduces the fraudulent activities;
(b) It avoids the checking of shares, deeds and
various papers,
(e) No share certificate is issued as the securities
are divisible;
(d) It reduces the various costs which require
secretarial help;
(e) It supplies better communication facilities
(f) Easy availability of data and information (i.e.
issue of bonus share, right share, dividend declaration, etc.) are available
which helps the shareholder to take decisions.
Disadvantages of Depository System:
The Depository System is not
free from snags. Some of them are:
(a) Number of frauds may be increased as there is no
physical checking;
(b) Practically, to set up a single depository is not
possible;
(c) MDS (Multiple Depository System) invites the
problems of coordination.
Disadvantages/Problems of the Depository System
Some disadvantages were about the depository system were known beforehand. But
since the advantages outweighed the shortcomings of dematerialisation, the
depository system was given the go-ahead.
Lack
of control: Trading
in securities may become uncontrolled in case of dematerialized securities.
Need
for greater supervision:
It is incumbent upon the capital market regulator to keep a
close watch on the trading in dematerialized securities and see to it that
trading does not act as a detriment to investors. The role of key market players
in case of dematerialized securities, such as stock brokers, needs to be
supervised as they have the capability of manipulating the market.
Complexity
of the system: Multiple
regulatory frameworks have to be confirmed to, including the Depositories Act , Regulations and the various Bye
Laws of various depositories. Additionally, agreements are entered at various
levels in the process of dematerialization. These may cause anxiety to the
investor desirous of simplicity in terms of transactions in dematerialized
securities.
- Current
regulations prohibit multiple bids or applications by a single person. But
investors open multiple demat accounts and make multiple applications to
subscribe to IPOs in the hope of getting allotment of shares.
- Some
listed companies had obtained duplicate shares after the originals were
pledged with banks and then sold the duplicates in the secondary market to
make a profit.
- Promoters
of some companies dematerialised shares in excess of the company’s issued
capital.
- Certain
investors pledged shares with banks and got the same shares reissued as
duplicates.
- There
is an undue delay in the settlement of complaints by investors against
depository participants. This is because there is no single body that is
in charge of ensuring full compliance by these companies.
Although the Depository System is not free from snags,
even then it is a boom to the world of capital market. It, no doubt, proves an
efficient transfer system and helps the investors and the company in various
forms. It overcomes the problems from bad delivery, counterfeit certificates,
etc. It also reduces various cost and expenses (i.e. Registration cost).
Dematerialization (DEMAT) is the move from physical
certificates to electronic book keeping. Actual stock certificates are slowly
being removed and retired from circulation in exchange for electronic
recording.
Dematerialization is the process by which physical share certificates of an investor are taken back by the
company/registrar and destroyed. Then an equivalent number of securities in the
electronic form are credited to the investors account with his Depository Participant.
Process of Dematerialization
Dematerialization is
done at the request of the investor. Investors will first have to open an
account with a DP (Depository Participant) and then request for dematerialization of certificates through the
DP.
Purchases made by an investor are
credited to his account and sales are debited. The securities held in
dematerialized form are fungible. In other words they do not have any
distinguishing features. Dematerialized shares do not have any distinctive
numbers. All the holdings of a particular security will be identical and
interchangeable.
Trading in dematerialized shares
commenced on the NSE in December 1996 where Reliance Industries was the first
company to trade its 100 shares in demat form. In case of the BSE,
dematerialization of shares commenced in the year December 1997.
The following are the steps involved in the process of
dematerialization:
· Dematerialization
starts with opening a Demat account. For demat account opening,you need to
shortlist aDepository Participant (DP) that offers Demat services.
· To
convert the physical shares into electronic/demat form, A Dematerialization
Request Form (DRF), which is available with the Depository Participant (DP),
has to be filled in and deposited along with share certificates. On each share
certificate, 'Surrendered for Dematerialization' needs to be
mentioned.
· The
DP needs to process this request along with the share certificates to the
company and simultaneously to registrars and transfer agents through the
depository
· Once
the request is approved, the share certificates in the physical form will be
destroyed and a confirmation of dematerialization will be sent to the
depository
· The
depository will then confirm the dematerialization of shares to the DP. Once
this is done, a credit in the holding of shares will reflect in the investor's
account electronically.
· This
cycle takes about 15 to 30 days after the submission of dematerialization
request
Dematerialization is
possible only with a Demat account, Learn about how to open a demat account to
understand dematerialization.
NSDL, the
first and largest depository in India, established in August 1996 and promoted
by institutions of national stature has established a state-of-the-art
infrastructure that handles most of the securities held and settled in dematerialized
form in the Indian capital market. Although India had a vibrant capital market
which is more than a century old, the paper-based settlement of trades caused
substantial problems like bad delivery and delayed transfer of title, etc. The
enactment of Depositories Act in August 1996 paved the way for establishment of
NSDL.
Using innovative and flexible
technology systems, NSDL works to support the investors and brokers in the
capital market of the country. NSDL aims at ensuring the safety and soundness of
Indian marketplaces by developing settlement solutions that increase
efficiency, minimize risk and reduce costs. At NSDL, we play a central role in
developing products and services that will continue to nurture the growing
needs of the financial services industry. In the depository system, securities
are held in depository accounts, which is more or less similar to holding funds
in bank accounts. Transfer of ownership of securities is done through simple
account transfers. This method does away with all the risks and hassles
normally associated with paperwork. Consequently, the cost of transacting in a
depository environment is considerably lower as compared to transacting in
certificates.
NSDL provides bouquet of services
to end investors, stock brokers, stock exchanges, custodians, issuer companies
etc. through its network of more than 260 Depository Participants / Business
Partners. NSDL has been able to win the trust of crores of investors and other
intermediaries, thus standing true to its tag line −Technology, Trust and
Reach. We at NSDL believe that ‘Every Indian should not only become an
‘Investor’ but a ‘Prudent Investor’ indeed.
Number of active demat accounts
with NSDL
The following table shows the number
of active dematerializiation accounts with National Securities Depository
Limited (NSDL) over a period of 15 years.
Year
|
No. of
DEMAT Accounts with NSDL (in lakhs)
|
March
2002
|
37
|
March
2003
|
38
|
March
2004
|
52
|
July
2005
|
65
|
July
2006
|
77
|
July
2007
|
78
|
March
2008
|
93
|
July
2009
|
99
|
July
2010
|
107
|
July
2011
|
117
|
July
2012
|
122
|
July
2013
|
128
|
July
2014
|
132
|
July
2015
|
139
|
Oct
31 2016
|
15,106,130
|
Why NSDL
In the depository system, the ownership and transfer of
securities takes place by means of electronic book entries. At the outset, this
system rids the capital market of the dangers related to handling of paper.
NSDL provides numerous direct and indirect benefits like
·
Elimination of
bad deliveries - In the depository
environment, once holdings of an investor are dematerialised, the question of
bad delivery does not arise i.e. they cannot be held "under
objection". In the physical environment, buyer was required to take the
risk of transfer and face uncertainty of the quality of assets purchased. In a
depository environment good money certainly begets good quality of assets.
·
Elimination of
all risks associated with physical certificates - Dealing
in physical securities have associated security risks of theft of stocks,
mutilation of certificates, loss of certificates during movements through and
from the registrars, thus exposing the investor to the cost of obtaining
duplicate certificates etc. This problem does not arise in the depository
environment.
·
No stamp duty for
transfer of any kind of securities in the depository. This waiver extends to equity
shares, debt instruments and units of mutual funds.
·
Immediate
transfer and registration of securities - In
the depository environment, once the securities are credited to the investors
account on pay out, he becomes the legal owner of the securities. There is no
further need to send it to the company's registrar for registration. Having
purchased securities in the physical environment, the investor has to send it
to the company's registrar so that the change of ownership can be registered.
This process usually takes around three to four months and is rarely completed
within the statutory framework of two months thus exposing the investor to
opportunity cost of delay in transfer and to risk of loss in transit. To
overcome this, the normally accepted practice is to hold the securities in
street names i.e. not to register the change of ownership. However, if the
investors miss a book closure the securities are not good for delivery and the
investor would also stand to loose his corporate entitlements.
·
Faster
settlement cycle - The settlement cycle follow
rolling settlement on T+2 basis i.e. the settlement of trades will be on the
2nd working day from the trade day. This will enable faster turnover of stock
and more liquidity with the investor.
·
Faster disbursement
of non cash corporate benefits like rights, bonus, etc. - NSDL
provides for direct credit of non cash corporate entitlements to an investors
account, thereby ensuring faster disbursement and avoiding risk of loss of
certificates in transit.
·
Reduction in
brokerage by many brokers for trading in dematerialised securities - Brokers
provide this benefit to investors as dealing in dematerialised securities
reduces their back office cost of handling paper and also eliminates the risk
of being the introducing broker.
·
Reduction in
handling of huge volumes of paper
·
Periodic status
reports to investors on their holdings and
transactions, leading to better controls.
·
Elimination of
problems related to change of address of investor - In
case of change of address, investors are saved from undergoing the entire
change procedure with each company or registrar. Investors have to only inform
their DP with all relevant documents and the required changes are effected in
the database of all the companies, where the investor is a registered holder of
securities.
·
Elimination of
problems related to transmission of demat shares - In
case of dematerialised holdings, the process of transmission is more convenient
as the transmission formalities for all securities held in a demat account can
be completed by submitting documents to the DP whereas, in case of physical
securities the surviving joint holder(s)/legal heirs/nominee has to correspond
independently with each company in which shares are held.
·
Elimination of
problems related to selling securities on behalf of a minor - A
natural guardian is not required to take court approval for selling demat
securities on behalf of a minor.
·
Ease in
portfolio monitoring since statement of account
gives a consolidated position of investments in all instruments.
·
Safety
There are various checks and
measures in the depository system to ensure safety of the investor holdings.
These include
·
A
DP can be operational only after registration by SEBI, which is based on the
recommendation from NSDL and their own independent evaluation. SEBI has
prescribed criteria for becoming a DP in the regulations.
·
DPs
are allowed to effect any debit and credit to an account only on the basis of
valid instruction from the client.
·
Every
day, there is a system driven mandatory reconciliation between DP and NSDL.
·
All
transactions are recorded at NSDL Central System and in the databases
maintained by business partners.
·
There
are periodic inspections into the activities of both DP and R&T agent by
NSDL. This also includes records based on which the debit/credit are effected.
·
All
investors have a right to receive their statement of accounts periodically from
the DP.
·
Every
month NSDL forwards statement of account to a random sample of investors as a
counter check.
·
In
the depository, the depository holds the investor accounts on trust. Therefore,
if the DP goes bankrupt the creditors of the DP will have no access to the
holdings in the name of the clients of the DP. These investors can transfer
their holdings to an account held with another DP.
·
The
data interchange between NSDL and its business partners is protected by
protection measures of international standards such as encryption hardware
lock. The protection measures adopted by NSDL are more than what is prescribed
in the SEBI Regulations.
·
Freeze
Facility : A
depository account holder (beneficiary account) may freeze securities lying in
the account for as long as the account holder wants it. By freezing the
account, account holder can prevent unexpected debits or credits or both,
creeping into its account. The following types of freeze facility available in
the NSDL system may be availed of by submitting freeze instruction to the DP in
the prescribed form.
o Freeze for debits only
o Freeze for debits as well as credits
o Freeze a particular ISIN in the
account
o Freeze a specific number of
securities held under an ISIN in an account
·
Certification
in Depository Operations : NSDL
has introduced a Certification Programme in Depository Operations (popularly
known as NCFM certification), and it has been made compulsory for all DPs to
appoint a person qualified in this certification in each of its branches. This
way, NSDL wants to ensure that each branch of a DP that services investors has
atleast one person who has thorough knowledge about depository system.
·
Investor
grievance : All
grievances of the investors are to be resolved by the concerned business
partner. If they fail to do so, the investor has the right to approach NSDL at
the following address:
·
Insurance
Cover : NSDL
has taken a comprehensive insurance policy to help DP to indemnifying investors
for the loss accrued to them due to errors, omissions, commission or negligence
of DP.
·
Computer
and communication infrastructure : NSDL and its business partners use hardware, software
and communication systems, which conform to industry standards. Further, the
systems are accepted by NSDL only after a rigorous testing procedure. NSDL's
central system comprises an IBM mainframe system with a back-up facility and a
remote disaster back-up site.
·
Machine
level back-up : The
IBM mainframe in which the data is processed has adequate redundancy built into
its configuration. There is a standby central processing unit (CPU) to which
processing can be switched over to in case of main system CPU failure. The disk
has RAID implementation, which ensures that a failure of hard disk will not
lead to loss in data. System has spare disk configuration where data is
automatically copied from the main disk upon encountering the first failure
(due to RAID implementation - first failure does not result in loss of
data).All network components like router, communication controllers etc., have
on-line redundancy and thus a failure does not result in loss of transaction.
·
Disaster
back up site : A
disaster back up site equipped with a computer identical to the mainframe
computer & computing resources has been set up at a distant location about
175 km away from Mumbai. The depository operations are often switched between
the computing resources at Mumbai office and disaster back up site to ensure
that the disaster site is always operational.
·
Back-up
in case of power failure : Continuity
in power supply to the main systems is assured by providing for
o Dual uninterrupted power supply
(UPS) for IBM-Mainframe and related components wherein the two UPSs are
connected in tandem. In case of failure of primary UPS, the secondary UPS takes
over instantaneously and thus, there is no interruption in operation, and
o Back-up diesel generator sets.
·
Periodic
Review: The
NSDL hardware, software and communication systems are continuously reviewed in
order to make them more secure and adequate for the size of business. These
reviews are a part of an ongoing exercise wherein security considerations are
given as much importance as operational efficiency.
As
on February 28, 2018
Number
of certificates eliminated (Approx.) (in Crore) 2976
Number
of companies in which more than 75% shares are dematted 8297
Average
number of accounts opened per day since November 1996 3879
Presence
of demat account holders in the country 88%
of all pincodes in the country
Central Depository Services (India) Limited (CDSL),
is a depository managed by
professionals, has been promoted by The Bombay Stock
Exchange (BSE) Limited along with a
cross section of several leading Indian and foreign
banks. CDSL’s objective is to provide
convenient, dependable and secure depository
services at an affordable cost to investors.
Presently, it is compulsory to settle all trades
done on any stock exchange in demat mode
only.
Although,
investors have an alternative to settle trades upto 500 shares in physical
form, in
practice, almost all trades on stock exchanges are
now being settled in demat mode only.
Dematerialisation or demat is the process of
converting the securities held in physical form
into an electronic record form or to directly allot
securities in electronic record form. These
electronic records
of securities are shown as “electronic balances” in the demat accounts of
investors. Any investor can open a demat account
through a Depository Participant (DP). The DP
is an agent of the depository and provides a link
between the account holder or Beneficial Owner
(BO), the Issuing Company, CDSL, the BOs broker and
the Stock Exchange. CDSL publishes
from time to time an updated list of DPs registered
with it.
Refernces:
1.
https://www.cdslindia.com/downloads/qaenglish.pdf
2.
https://www.scribd.com/doc/36965289/Depository-System-in-India
3.
https://www.nseindia.com/content/us/ismr2009ch5.pdf
4.
https://nsdl.co.in/.../pdf/Bye-Laws%20%28Amended%20upto%20May-2016%29.pdf
5.
https://www.rinfra.com/documents/1142822/.../InvestorGuide-Depositaryservices.pdf
7.
www.pondiuni.edu.in/.../Merchant%20Banking%20and%20Financial%20servicest20 www.lpude.in/academics/online_study_material_for_management.php
1.
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